How to prepare balance sheet

2. Classifications on balance sheet

All balance sheets are normally classified: that is,
different financial elements on a balance sheet are grouped into categories and
presented under a common caption. This is a general practice that helps to
compare balance sheets of different companies. You can see an example below.
For instance, if there are two companies within different industries, they may
have different items (components) going into the Current Assets category.
However, due to this classification rule, it may sometimes not be as relevant
to compare components of current assets. Instead, you may just compare the
total current assets of the two companies, and that may be all you need in your
analysis.

Illustration 1: Example of classifications on the balance
sheet (horizontal)

Assets

Liabilities

Current Assets

Current liabilities

Investments

Non-current liabilities

Fixed Assets

Intangible Assets

Equity

Other Non-current Assets

Common Stock

Retained Earnings

The example above shows a balance sheet in a horizontal
format: Assets are on the left side, and Liabilities and Equity are on the
right side. It is also possible to present a balance sheet in a single column
format (vertically) as follows:

Illustration 2: Example of classifications on the balance
sheet (vertical)

Assets

Current Assets

Investments

Fixed Assets

Intangible Assets

Other Non-current Assets

Liabilities

Current liabilities

Non-current liabilities

Equity

Common Stock

Retained Earnings

It is a matter of preference, but normally balance sheets
are presented vertically as shown in Illustration 2.

Important term to remember, as we discuss balance sheet
classifications further, is a balance sheet date. A balance sheet date is the date as of which the balance sheet is prepared. For example, most
businesses prepare their balance sheets at least once a year as of December
31. However, the balance sheet date is not the date when a balance sheet is
actually prepared and becomes available.

As you may have noticed in Illustration 1, assets are on the
left side, and liabilities and equity are on the right side. There is a reason
why they are presented liked that. Total assets equal the sum of total
liabilities and total equity. This is a fundamental accounting equation that
results in this equality:

Assets = Liabilities + Equity

This equation must hold true in any balance sheet, and if it
doesn't, then it is due to an error somewhere in the balance sheet. You can use
this rule in situations where your assets don't equal your liabilities and
equity.

The reason the equation must hold true is because assets are
economic resources of a business used to accomplish its main goal, i.e.
increase owners' wealth. Liabilities and equity are the sources of such
assets. In other words, liabilities and equity show where assets were obtained
from. Liabilities are claims of third parties for resources provided to the
business (e.g. creditors). Equity is claims of business owners for resources
they invested in the business. Equity, therefore, is an indicator of how many
assets the owners can claim in the business after all liabilities are settled.
The difference between assets and liabilities (i.e. equity) is sometimes called net worth.

Any trial balance account (trial balances are a starting
point in preparing a balance sheet – see further) has a balance. An account
may have a debit or credit balance. The normal account balance also indicates
whether the account is increased or decreased when it's debited or credited.
There are rules stating which account has a debit or credit balance. The
illustration below shows accepted conventions about such balances:

For example, an asset account called Cash increases when
it's debited and decreases when it's credited. The Cash account normally has a
debit balance.

Note that there are "contra" accounts. Such accounts are
opposite to their related accounts and thus have a different normal balance.
Contra accounts are presented as a reduction to their related accounts on the
balance sheet. An example of such accounts is Accumulated Depreciation. This
account has a credit balance and is related to the Fixed Assets account. On
the balance sheet, Accumulated Depreciation (credit balance) is shown under
Fixed Assets (debit balance) and reduces the balance of Fixed Assets creating
Net Fixed Assets.

Going back to the accounting equation, note that assets
normally have debit balances, and liabilities and equity have credit balances: